What happens if you don't use your 529 plan?

If you'd like to put money aside for your child's academic future, a 529 plan can be a valuable resource. However, those funds may seem essentially locked up for education-related expenses.

What happens if you don't use your 529 plan, though? You have more options than you might think.

A 529 plan, or qualified tuition program, allows you to save for education-related expenses on behalf of a minor such as a child or sibling. Technically, there are two types of 529 plans: savings plans and prepaid tuition plans. 529 savings plans are by far the more widely used option and the focus of the following strategies, but there are many other college savings plan options available.

Whatever money you put into a 529 savings plan grows tax-deferred, meaning you won't owe federal income tax on any interest or returns your contributions earn each year. Distributions also do not incur federal income tax as long as the money goes toward qualified higher education expenses such as tuition, room and board, books and supplies.

Contribution limits, investment options and state income tax deductions for contributions vary by state, so compare 529 plan options up front. Many states also offer tax-deferred growth and tax-free distributions as plan benefits to encourage saving for college early.

After you've designated a child as the beneficiary of a 529 plan, there's still a chance they won't end up needing it. This could happen for many reasons, including earning scholarships, a serious illness or a lack of interest in higher education.

These plans do restrict how their funds can be used, but federal law offers alternatives for accessing money in a 529 plan without taxes or penalties. Note that state tax laws can differ from federal law, so be sure you understand how your state will handle tax distributions before making any of the moves below.

The Secure 2.0 Act, passed in late 2022, will allow people to make penalty- and tax-free rollovers from 529 plans into a Roth IRA starting in 2024.

Criteria:

• The 529 beneficiary must be the IRA owner and will have to have earned income.
• Rollovers will be subject to the annual Roth IRA limits in the year they are rolled, less any contributions you've previously made for the year (for example, limits are $7,000 in 2024 and 2025 under age 50; age 50 or older can add an additional $1,000 catch-up contribution).
• 529 must be at least 15 years old.
• Any contributions or earnings from the past five years are not eligible to be rolled into the Roth IRA.
• The lifetime maximum of funds rolled over is $35,000.

Federal tax code allows 529 account holders to change the beneficiary to a different family member.

Permissible family members include the original beneficiary's:

• Spouse
• Child
• Grandchild
• Sibling or stepsibling
• Parent or stepparent
• Nephew or niece
• Aunt or uncle
• First cousin

The spouse of any of these relatives may qualify as well.

While many people think of 529 plans as a tool to save for college, the law doesn't ask you to use the money for a traditional four-year college or university. Rather, it requires you to put the money toward an "eligible postsecondary school," which has a broader definition. The only true restrictions are that the school must be accredited and eligible to participate in the federal student aid program.

Other available options for your 529 funds include:

• K-12 tuition expenses, up to a $10,000 limit.
• Vocational schools.
• International schools.
• Apprenticeship programs registered with the U.S. Department of Labor.
• Wilderness first aid course or the Outward Bound program.

Another way to avoid federal taxes and penalties on 529 plan distributions is by repaying up to $10,000 in student loans for the designated beneficiary or their siblings, including stepsiblings. This $10,000 limit is per person, not per account. If your designated beneficiary has two older siblings who graduated with student loan debt, a plan could put $10,000 toward each of their loans.

Since you can change a 529 plan's designated beneficiary, it's even possible to make yourself the beneficiary and use up to $10,000 in plan distributions to repay your own student loans, whether they were for your child's education or your own. Be aware, however, that student loan interest repaid from a 529 plan distribution isn't eligible for a federal tax deduction.

What happens if you don't use your 529 plan for any educational purpose at all? Well, you wouldn't forfeit your savings or be stuck with an account balance you can't touch. You'd simply pay taxes and penalties on your withdrawals.

On your federal tax return, this means you will include the earnings that are distributed as ordinary income and would owe a 10% penalty on any investment returns your contributions have generated. In other words, you'd essentially lose the tax-deferred growth benefit the account provided. This penalty doesn't apply, however, if you take a distribution because your beneficiary:

• Earned a scholarship or grant.
• Enrolled in a military academy.
• Became disabled or died.
• Received funds from an employer for their educational expenses.

In cases like these, you may not have to pay penalties, but you may still owe state taxes on your withdrawals if you received a state income tax deduction when you put that money in the account. You may be able to reduce the taxes and penalties owed by paying the money directly to the beneficiary if their tax bracket is lower than yours. Another option is to wait to withdraw the money until you're in a lower tax bracket—perhaps after a layoff or during retirement.

Saving for college using a 529 plan is a tax-efficient financial strategy that can help you accumulate wealth for a loved one. When it's time to distribute those assets, you want to ensure they have a meaningful impact on your family member's future. If that impact isn't related to higher education, that's okay. You can adapt and adjust.

The good news is you don't have to rush to make a decision. Unlike other savings vehicles—such as traditional IRA, 401(k) or 403(b)—you don't have to withdraw money from a 529 plan by a certain date. With no distribution deadline, you can take your time and consider all of your options.

If you don't need the account balance for a near-term purpose, you can leave it untouched in case a relative needs it for graduate school or your spouse decides to pursue an MBA. You can continue investing in your 529 for years, preserving the account's tax benefits.

Consider connecting with a Thrivent financial advisor to review your options if you find yourself with an unused 529 plan and you're unsure of the best way to proceed.